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ACCA F2 Management Accounting

ACCA Paper F2 (FIA Paper FMA) Management Accounting

ACCA F2 Management Accounting

SI. No
1. 2. 3. 4. 5.

Name of the Chapter
The Nature, Source and Purpose of Management Information Cost Accounting Techniques Budgeting Standard Costing Performance Measurement

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ACCA F2 Management Accounting

Chapter 1

The Nature, Source and Purpose of Management Information
The Characteristics of Good Information The qualities of good information can be summarized in the word “ACCURATE”:         Accurate, Complete, Cost-beneficial, User-targeted, Relevant, Authoritative, Timely and Easy to use

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evaluate investment choices and monitor/control the operating performance and the orderly conduct of the business. plan resource allocation. accumulation. interpretation and reporting of information used by management to set targets. Control: Monitoring of performance during the course of business and taking remedial action steps as necessary  Page | 4 . but also along the way as implementation proceeds. which is aimed at external stakeholders) Focused on present and future performance (as opposed to financial accounting. analysis. not only with regard to the selection of strategies. while financial accounting uses only financial measures.ACCA F2 Management Accounting KEY KNOWLEDGE Management Accounting The process of identification. which reports past performance) Not required by law and not regulated by accounting frameworks (as opposed to financial accounting. Decision-making: Making choices. which provides a holistic view of company’s performance) Employs non-financial indicators as well financial. compared to Financial Accounting    Aimed at internal users (as opposed to financial accounting.   Managerial Processes The key processes which face management can be divided into:   Planning: Defining objectives and appropriate strategies for attaining them. Differences in purpose and scope. preparation. measurement. which is a legal requirement and is regulated by accounting frameworks) Focused on specific areas or activities (as opposed to financial accounting.

current expenses and capital expenditure Page | 5 . It answers the question “What business or businesses should we be in and what are our objectives? Strategic Tactical Operational Tactical: this embraces the short-term (budgetary periods).ACCA F2 Management Accounting Planning Planning occurs at different levels of the organisation: Strategic: covers the “big view” of the organisation. but not current expenses other than marketing expenses Profit centres: Responsible for revenues and current expenses Investment centres: Responsible for revenues. Functional (or operational) strategy: this refers to day-to-day target-setting Responsibility centers Related to the above is the notion of responsibility that attaches to each level of an organisation: “Responsibility” centres Cost Centres Revenue Centres Profit Centres Investment Centres Cost centres: Responsible for current expenses only Revenue centres: Responsible for revenues.

These costs can have the character of “period” costs. it is a convention to break down costs into: KEY KNOWLEDGE Production vs. Page | 6 . selling.ACCA F2 Management Accounting KEY KNOWLEDGE Sources of data The sources of data are almost infinite. also variable and fixed) which relate to the production of goods. this is also referred to as manufacturing or factory cost. Non-production costs: These are expenses that are incurred independent of production and include administrative. Indirect costs Direct costs: are costs that can be directly attributable to a product. which provide the value at which goods are placed in inventory (prior to sale) and form the “cost of goods” value when sold. KEY KNOWLEDGE Classifications of cost In financial accounting. Non‐Production costs Production costs: These are costs (both direct and indirect. KEY KNOWLEDGE Direct vs. distribution and finance costs. Indirect costs: these are costs that cannot be directly attributable to a product. accumulated. It is these costs. as they relate to the period of time in which they occur. and they must be selected and evaluated carefully based on reliability and relevance.

Step costs: costs that remain fixed within a defined range of production. Direct costs are by their nature variable in behavior. Variable costs: vary in proportion with the volume produced. but at a certain level of output increase in a significant way to a new (fixed) level. A variety of indirect costs are fixed.ACCA F2 Management Accounting KEY KNOWLEDGE Fixed vs. the variable cost per unit remains fixed.” Other types of costs: Mixed costs: these are costs that contain a fixed and a variable element. while a fixed cost per unit falls with a rise in the level of activity. Variable costs Fixed costs: are costs that remain constant regardless of the volume of production. “Although a variable cost increases with the level of activity. Page | 7 .

To determine the total costs.ACCA F2 Management Accounting Chapter 2 Cost Accounting Techniques Materials The ordering. the following data is required: Q = order quantity D = quantity of product demanded annually P = purchase cost for one unit C = fixed cost per order (not incl. the purchase price) H = cost of holding one unit for one year Page | 8 . Economic Order Quantity This is a method which seeks to minimize the costs associated with holding inventory. receiving and issuing of materials from inventory must be controlled according to procedures and documented at all stages with forms appropriate to the purpose. The controls and procedures are designed to monitor inventory movements so as to minimize discrepancies and losses and theft.

i.ACCA F2 Management Accounting The total cost function is as follows: Total cost = Purchase cost + Ordering cost + Holding cost which can be expressed algebraically as follows: TC = PxD + C x D/Q + H x Q/2 It is this total cost function which must be minimized. Page | 9 . C x D/Q = H x Q/2 Rearranging the above and solving for Q results in Labor Direct labor refers to work which is directly involved in the manufacture of a product.g. The optimal order quantity (Q*) is found where the Ordering and Holding costs equal each other. Ordering costs rise the more frequently one places (during the year). and Holding costs rise the fewer times one places orders (due to larger quantities being ordered each time). the supervisor’s salary or that of a security guard) forms part of Overhead costs. Indirect labor (e.e. It follows that there is a trade-off between the Ordering and the Holding costs. Recognizing that:    PD does not vary.

Absorb Cost Unit The focus (above) is production. Allocate/Apportion to Cost Centers Production A 1. Reapportion from Service to Production Production A Production B 4.ACCA F2 Management Accounting Absorption Costing This is one method which seeks to make the link between overheads and (product) cost units. Overhead costs that are not incurred at the time of production do not find their way into inventory. Total Production Costs Direct Costs Indirect costs (overheads) 2. It is useful to think of production costs as being those that end up as part of the inventory (valuation) while other (non-production) costs are incurred outside. The diagram below provides a useful roadmap. and normally after the product leaves inventory. Contribution Contribution is defined as the difference between Sales revenue and the marginal cost of sales. Allocate Production B Service C 3. or Contribution = Sales – Variable costs (both production and non-production) Page | 10 .

a profit and loss statement for the Years 1 and 2 is shown on the next page. Example Below is data on a manufacturing company.500 $ 7. Selling price (per unit): Cost card (per unit): Direct materials Direct labor Variable production O/Hs Total variable costs There is a variable selling cost of $2 per unit Year 1 (units) Budget (normal) production Actual Production Actual Sales Actual fixed production O/Hs Actual SGA costs 1. if it produces/sells an additional unit of output.000 Year 2 (units) 1. Page | 11 . This allows the company to be able to quantify the amount by which its costs rise.150 $16.ACCA F2 Management Accounting Marginal costing A marginal approach to costing focuses on the variable (marginal) costs generated in a business and considers fixed costs as period costs.500 $ 7.100 1.100 1.100 1.000 950 $16.000 120 45 18 9 72 Based on the above data. Assume that the beginning inventory is zero.

400 Inventory is valued at variable production costs.400) (1.100 X $72) Less: closing inventory (50 x $72) Less: Variable selling costs (950 x $2) (1. Page | 12 .ACCA F2 Management Accounting Profit/Loss (Marginal costing) Year 1 $ Sales (950/1.150 units) Less: Variable cost of sales Opening inventory Production costs: o Variable (1.000) 29.000 (68.900) 43.150 x $2) Contribution Less: Fixed production O/Hs Less: SGA costs Profit 72.600) 0 0 3.000 Year 2 $ 138.000 x $72) (1.300) 52.200 (82.200 (3.900 (16. Absorption Costing This method argues that focusing on marginal costs is potentially misleading in the longer run because fixed production costs have also to be covered.000 79.500) (7. Accounting conventions require that fixed production costs be reflected in each unit produced.800) (2.700 (16.500) (7.000) 20.600 114.

000 16.000 Year 2 $ 138.000 (9.350 114.150 x $2) Less: SGA costs Profit Inventory is valued at the full production costs.650 Page | 13 .300) 28.150) 29.950 72.000 45 18 9 15 87 2.000 x $72) (1.350) 1.100 X $15) Less: closing inventory (50 x $87) Over/(under) absorption Gross Profit Less: Variable selling costs (950 x $2) (1.950 0 4.000 x $15) (1.500 (4.050) 37.150 units) Less: Variable cost of sales Opening inventory Production costs: o Variable (1.850 0 0 (100.500 (84.900 7.100 X $72) o Fixed (1.000 (8.900) 20.000 79.ACCA F2 Management Accounting Revised cost card (Absorption costing) Cost card (per unit): Direct materials Direct labour Variable production O/Hs Fixed production O/Hs Total production costs Profit/Loss (Absorption costing) Year 1 $ Sales (950/1. 1.300 7.200 15.

the distinction lies in the identification of costs with specific batches. The accumulated costs of production can be averaged over the number of items produced. moving through a series of processing stages. then that (scrap) value will reduce the total costs. Page | 14 . which are numbered (separately identified) for this purpose. The average cost is determined by the following formula: Average cost per unit = Total cost of inputs – Scrap value of rejected units No. in its delivery. of units of input – Normal loss The total cost of inputs refers to labour. If losses occur along the way that necessitate the scrapping of defective units. This is appropriate in situations where each product or service is distinct. Batch costing is similar to job costing. and possibly unique.ACCA F2 Management Accounting Summary of Absorption costing and Marginal costing formats Absorption Costing Revenue Less: Cost of Sales Variable/Fixed production costs Gross profit Less: Expenses Variable/Fixed non-production costs Net Profit Marginal Costing Variable production/ non-production costs Contribution Fixed production/ non-production costs Job costing / Batch costing This refers to the calculation of costs associated with a specific job or customer order. then to the extent that these items fetch a scrap value. Process Costing Process costing is a technique that applies to the mass production of a large number of identical products. materials and overhead costs of production.

It is therefore considered to have an EU of 35%. FIFO costing separates the costs that were incurred in the previous period from costs of the current period. Weighted average method The weighted average method makes no distinction between units that were started (but not finished) in a previous process and those started in the current process. an accounting is made of the number of units introduced into a process with the expectation that a normal loss will be incurred. Abnormal gains and losses are accounted for as an adjustment to the accounts using the same value as the “good” output (deducted in the case of loss and added in the case of gains). then the unit has a degree of completion of 35% in terms of value.ACCA F2 Management Accounting Similarly. The number of good units emerging from a process will therefore be the number of units entering it. processing costs are averaged over all the units. or some other objective physical measurement) Net realizable value = Final sales value – Incremental processing costs By-products are goods which are incidental to the production process and which generate cash from sales. Until they go their own (separate) ways. when completed. Page | 15 . The cash received for by-products can be viewed as a bonus that reduces production costs. the costs of production during the joint processing cannot be physically distinguished. Equivalent units (EU) This refers to the way in which partially-completed output (“work-in-progress” or WIP) is expressed. Joint products / By-products Joint products are two or more products that share a common processing path until the point of separation. There are different methods used to apportion common costs to such products at the point of separation:    Market value (based on expected sales price) Number of units (litres. If an unfinished unit of product contains 35% of the labour and materials costs of a complete unit. though the amount is modest in comparison to the overall revenues of the firm. are visually identical. which is normally expressed in monetary terms. tons. minus the expected number lost in processing. Since all the units. First-In-First-Out (FIFO) method The FIFO method does make a distinction between units that were started in a previous process and those begun in a current process.

Customer service budget. expressed in financial. Admin budget Pro-forma income statement The financial budget sequence    Capital budget Cash budget Pro-forma balance-sheet and pro-forma statement of cash-flows Page | 16 . Distribution budget.ACCA F2 Management Accounting Chapter 3 Budgeting Budgeting: definition and purpose Quantitative plan for the future. Factory overhead budget Cost of Sales budget R&D budget. used to: a) Communicate Objectives b) Motivate Employees b) Control Activities b) Evaluate Performance The master budget process   Annual frequency. preferably revised on a regular basis (rolling budget) Based on organization’s objectives. quantitative and qualitative measures The operating budget sequence        Sales budget Production budget Ending inventory budget Direct materials budget. Direct labour budget. Marketing budget.

Operating budgets are modelled on what will emerge as the company’s income statement. quantities.) and price specifications.g. etc.ACCA F2 Management Accounting Operating budgets These are budgets that quantify the revenues and costs relating to a company’s activities at a disaggregated level. They require both volume (e. units of output. meaning that there is direct input from department and functional levels. Examples include:         Sales budget Production budget Direct material usage Direct material purchases Direct labour budget Factory overhead budget Selling & distribution budget Administrative expenses budget Page | 17 . hours.

The range for r is: -1 < r < +1 The coefficient of determination measures the degree to which the variation in the dependent variable can be explained by the independent variable (x). lies at the basis of economic value.2 139. Discounted cash flow (DCF) techniques The preeminence of cash Cash.ACCA F2 Management Accounting The “disaggregation” of budgets referred to above allows the practice of “responsibility” accounting. It is a better indicator of wealth when compared with measures defined by accounting conventions. Page | 18 .0 81. Profit/(Loss) Probability 340 766 278 450 -230 10% 20% 50% 18% 2% 100% Expected Value 34.measures the strength of the linear association between the variables.0 -4. such as accounting profit. The correlation coefficient – denoted by r -. Cash is used to pay the bills and bonuses.6 Regression analysis This is a statistical tool used to describe the relationship between two sets of variables.6 402.0 153. Expected Value This is the average of possible outcomes weighted by the probability of each outcome. It is denoted as r2 and its range is: 0 < r2 < 1 The use of spreadsheets is a basic skill that all accountants should possess. both its receipt and possession.

It follows that the longer one waits for a receipt of cash. PV x (1+r) = FV PV = FV (1+r) Page | 19 . the less that cash is worth in today’s terms. The above refers to “one-period” discounting. If a company has to raise the necessary cash for its activities. what should the value be after one year? Present Value (PV) 100 Interpreting “r”:    Future Value (FV) 100 x (1+r) As opportunity cost: what we “sacrifice” by not having it now. It reflects the opportunity cost to the investors (what investment alternatives they have) on a risk-adjusted basis. As cost of capital rate: representing the return that capital providers expect From a company’s point of view. To compensate for the delay. then this is the rate it must pay. with r corresponding to the period.ACCA F2 Management Accounting Timing and value Tracking and measuring cash flows on a time-adjusted basis is critical: cash received quickly can be used to repay debt (avoiding interest costs) or invested (earning interest). As risk-adjusted rate: representing the riskiness of not getting the money back. this is the rate of return that the business must generate for its capital providers (shareholders and lenders). Among other factors. its purchasing value may diminish due to the effects of inflation. Cash paid with a delay can reduce costs (as long as penalties are not incurred). Discounting The above relationship between PV and FV: can be re-arranged to: with r representing the discount rate. Instead of receiving USD 100 today. assume it will be received after one year.

9 Added together results in total PV = 426.10)3 100 (1.10)5 86. discounted at 10% p.9 105 (1.10 90. then the discounting effect will be: PV = FV (1+r)n Where “n” refers to the number of periods. Note: If all the cash flows had been equal – say 100 – then the PV calculation would have been simplified: FV discounted: 100 1.10)4 100 (1.10)5 Page | 20 . will be PV = 100 = 82.10)2 100 (1.6 125 (1. 100 received after two years.7 140 (1.10 100 (1.9 100 (1.ACCA F2 Management Accounting If discounting is done over more than one period. This allows one to discount future values into present values and can be applied to a series of cash flows: Year: Future Values: 1 100 2 100 3 125 4 105 5 140 If discounted at r = 10%. then the above cash flows can be restated at their present values: FV discounted: PV: 100 1.6 (1.10)2 82.a. Thus.10)4 71.10)3 93. Reducing future cash flows – of different timings and amounts – to one PV is a powerful tool.10)2 This reflects that the uncertainty of getting money back increases with time.

9 Year 0 amounts denote the present and are automatically = PV.9 In the table above.7 140 86. Page | 21 . The NPV of the above cash flows is therefore = 226.1 The addition of the above is = 379 Net Present Value (NPV) To add meaning to the future cash flows. the (simple) payback period is in Year 2. Discounted Payback We can apply the concept of discounting to the Payback method in order to capture the time value of money element.1 68. we can include the amount invested (which gives rise to the FVs): Year: 0 1 2 3 4 5 Investment: (200) FV: PV: (200) 100 90.9 100 82.9 105 71.ACCA F2 Management Accounting PV: 90. Relevant Cash Flows When evaluating projects.6 75. Year: 0 1 2 3 4 5 Investment: (200) FV: PV: (200) 100 90. The Discounted Payback period is longer (Year 3).9 105 71.3 62. cash flow projections must meet the criteria of relevance.7 140 86.6 125 93.6 125 93.9 100 82.9 82.

If. however. are any opportunity costs incurred as a result of accepting the project. NPV = 0. if they are related to a calculation of taxes due. Page | 22 . the higher the better. Committed costs. these are also called “incremental” cash flows. at a discount rate r. IRR: An IRR in excess of a hurdle rate (set by the company) indicates acceptability. Any change in the amount of taxes paid is a very relevant cash flow! Internal rate of Return (IRR) The internal rate of return (IRR) is defined as the discount rate (r) at which the net present value (NPV) of a stream of cash flows will be equal to zero. Cash flows that are created (or discontinued) as a result of taking the decision (to undertake the project) are relevant. More subtle. Non-cash expenses Depreciation is an example of a “non-cash” expense. but no less important. One may need to work with depreciation. Cash flows which occur whether the project goes ahead or not are not relevant. Comparison of NPV and IRR methods The following decision rules apply to appraisal methods: NPV: Positive NPV projects are acceptable. the higher (the IRR) the better.ACCA F2 Management Accounting Relevance refers to cash flows that are relevant to the decision whether to accept a project or not. then IRR = r The IRR includes among its assumptions the following: any cash flows generated in the course of a project being evaluated are calculated as being reinvested at the IRR rate. Allocated (overhead) costs. Included in relevant cash flows would be any investments in equipment and working capital required by the project. Also not relevant are:     Sunk costs. In other words.

Fixed vs. In each of these cases.e. management must identify any factors that will prevent the company from surpassing a certain level of activity. A bank. i. as it relates return to amount invested. they were not subject to modification during the period to which they referred. Example Page | 23 . EXAMPLE Year A B 0 -500 -500 1 100 500 2 600 155 IRR 20% 25% NPV (9%) 97 89 Principal budget factor When a budget is prepared.000 -7. there is a limiting factor at work.000 8. for example. may be constrained from developing an extensive branch network owing to the scarcity of suitably-skilled professional staff.850 IRR 20% 18% NPV: 10% 454 545 14% 263 263 16% 172 129 Intuitively. Equal investment amounts do not necessarily remove the ambiguity.500 1 6. IRR should be preferable. or production may be constrained by the built capacity of the plant or by the level of demand for a company’s products. flexible budgets Traditional budgets tended to be rigid.ACCA F2 Management Accounting EXAMPLE Year A B 0 -5.

Based on the data (below). and the fixed cost of labour is $75.200 units Costs: Materials 90.000 Labour 225.075 units is $209. Page | 24 .000 100. In order to look back at what its budget would have been had the actual (higher) level of activity been anticipated.000 Fixed O/Hs 100.000 1000 75.000 Total 375.ACCA F2 Management Accounting A producer of office equipment has a budget for the coming year: Output: 1.375.000 100.000 Total 415. the   variable cost of labour is $125 per unit.000 1200 90.000 Output: Mats Labour Fix Total Therefore the cost of labour at output of 1.000 225.000 Labour 200.000 200. 20% higher than originally projected and it has therefore increased its production by a similar amount. the company observes that sales are running ca.000 Fixed O/Hs 100.075 units.000 After 3 months. this is effectively a re-calibration of the original budget.000 Prepare a flexed budget for an output level of 1. Output: 1. management can prepare a “flexed” budget.000 415.000 375.000 units Costs: Materials 75. It allows management to re-focus their efforts without losing time tracking “artificial” spending excesses according to the original budget.

Unrealistic budgets – with unachievable targets – can be de-motivating (as can budgets which are easily achieved. since most people stop working when they reach the targets!). Page | 25 . Bottom-Up budgets allow useful employee input.ACCA F2 Management Accounting KEY KNOWLEDGE Behavioural Aspects of Budgeting There are numerous inter-relationships between types of budgets. but they may create exaggerated expectations on the part of the employee that his/her voice will be heard. budgeting processes and the motivation of employees: Top-Down budgets may be necessary from a coordination point of view. however they can be de-motivating to employees.

100 $16.100) Page | 26 .ACCA F2 Management Accounting Chapter 4 Standard Costing Absorption Costing This method argues that focusing on marginal costs is potentially misleading in the longer run because fixed production costs have also to be covered. Accounting conventions require that fixed production costs be reflected in each unit produced.100 $16.500/1. Fixed Overhead Absorption Rate (FOAR) = Budgeted production O/H Budgeted level of production Year 1 (units) 1.500 Year 2 (units) 1.500 Budget (normal) production Actual fixed production O/Hs Fixed Overhead Absorption Rate (FOAR) = $15 ($16.

000 units Sales: 950 units Materials: 4. we now have a basis on which the production department can keep track of the fixed overheads being generated as the manufacturing process proceeds.000 units $120 / unit Actual results Production: 1. Actual output (units) x OAR = Fixed O/H absorbed Basic variance analysis The following data is from a manufacturing company Budget Production: Sales: Sales Price: 1.000 Sales price: $115 / unit Cost card (per unit) Materials (5kgs x $9 per kg) Labour (3hrs x $6 per hr) Variable O/Hs (3 hrs x $3 per hr) Fixed O/Hs (3 hrs x $5 per hr) 45 18 9 15 87 Page | 27 .100 units 1.900 kg.ACCA F2 Management Accounting Cost card (Absorption costing) Cost card (per unit): Direct materials Direct labour Variable production O/Hs Fixed production O/Hs Total production costs 45 18 9 15 87 Having established the OAR.025 Labour: 3. $19.050 Variable O/Hs: $9.250 Fixed O/Hs: $17. $45.100 hrs.

750 (A) Page | 28 .400 (A) Sales price variance   950 units should have sold @$120 Actual revenues (950 units x $115) Sales price variance Material variances (i)   Material price variance Materials used (4.900 kg) should have cost @ $9 Materials (4.000 950 50 (A) $1.000 109.900 kg) did cost 44.000 950 50 (A) $2.250 4.650 (A) Sales volume variance (Marginal costing)   Budgeted sales volume Actual sales volume Sales volume variance @ standard contribution ($120-$72) 1.025 114.ACCA F2 Management Accounting Variance calculations Sales volume variance (Absorption costing)   Budgeted sales volume Actual sales volume Sales volume variance @ standard margin ($120-$87) 1.100 45.

900 kg 100 kg (F) $900 (F) $ 25 (A) 18.000 units did take Labour efficiency variance @ standard $6 Labor total variance: Variable O/H variances (i)   Variable O/H expenditure variance 3.050 (A) 9.050 $450 (A) 3.100 hrs) did cost Labour rate variance (ii)   Labour efficiency variance 1.100 hrs 100 hrs (A) $600 (A) $ 1.000 units did use Materials usage variance @ standard $9 Materials total variance: Labour variances (i)   Labour rate variance Labour (3.100 hrs did cost $925 (A) 5.100 hrs should have cost @ $3 3.600 19.250 Page | 29 .300 9.100 hrs) should have cost @ $6 Labour (3.000 units should have taken @ 3 hrs 1.000 hrs 3.000 kg 4.ACCA F2 Management Accounting Materials price variance (ii)   Material usage variance 1.000 units should have used @ 5 kg 1.

000 units should have taken @ 3 hrs 1.000 (A) This can be broken down into two components: (i)   Fixed O/H expenditure variance Budgeted O/H should have cost (1.100 units 1.000 units did take Variable O/H efficiency variance @ standard $3 Variable O/H total variance: 50 (F) 3.100 hrs 100 hrs (A) $300 (A) $ 250 (A) Fixed O/H total variance (Absorption costing)   Overhead actually incurred Overhead absorbed (1.000 $15.000 units 100 units (A) $1.000 $ 2.000 hrs 3.000 $500 (A) Page | 30 .100 units x $15) 16.500 (A) 17.500 Actual O/H cost Fixed O/H expenditure variance (ii)   Fixed O/H volume variance (Absorption Costing) Budgeted production Actual production Fixed O/H volume variance @ standard $15 1.ACCA F2 Management Accounting Variable O/H expenditure variance (ii)   Variable O/H efficiency variance 1.000 units x $15) Fixed O/H total variance $17.

motivated/better trained workers. deficient work organization. complexity and bureaucracy Page | 31 . better materials and/or equipment Poorly trained workers. waste.ACCA F2 Management Accounting Interpreting variances Material price Favourable: Adverse: Material usage Favourable: Adverse: Labour rate Favourable: Adverse: Labour efficiency Favourable: More efficient production. poor purchasing. better purchasing/negotiation. cheap workers Wage inflation Better quality materials. poor quality control. materials or equipment Low pay rates. more efficient use of ancillary services Poor cost disciplines. better quality materials Adverse: Overhead expenditure Favourable: Adverse: Cost savings. theft Unanticipated discounts received. cheaper (substandard) materials Price inflation. more efficient processing Substandard material.

750 (A) 26.000 Page | 32 . and if possible quantify. as well as apply common sense to the materiality and controllability of specific variances. At the same time. management needs to review standards for their relevance and usefulness. Budgeted profit (Absorption costing) Sales volume variance Sales price variance 1.ACCA F2 Management Accounting Overhead volume Favourable: Adverse: Using production capacities beyond the level budgeted Under-utilization of production capacities Inter-connections among variances As can be seen above. It is management’s responsibility to understand these relationships and to be able to anticipate.650 (A) 4. a factor causing a favourable variance may at the same time be the cause of an adverse variance in another part of the company’s operations. Reconciliation of budgeted profit and actual profit Operating statement Prepare a reconciliation between the profit budgeted and that realized.600 Cost variances: Materials Price Usage Labour 900 F A 925 33. the impact of their actions on overall performance.

325 (A) 23.ACCA F2 Management Accounting Rate Efficiency Variable Expenditure Efficiency Fixed Expenditure Volume Actual profit 950 50 450 600 300 500 1.275 Note: Closing inventory is valued at standard cost Operating Statement based on Marginal costing Budgeted contribution (Marginal costing) Sales volume variance Sales price variance 2.750 (A) 40.400 (A) 4.850 Cost variances: Materials Price Usage Labour Rate Efficiency Variable 450 600 900 F A 925 48.500 4.000 Page | 33 .275 3.

500 500 (17.275 1.525 16.325 (A) 39.000) 22.525 Fixed O/Hs Budgeted Fixed O/Hs Expenditure variance Actual profit Page | 34 .ACCA F2 Management Accounting Expenditure Efficiency Actual contribution 50 950 300 2.

operating margin and ROCE).g. defining the industry the firm competes in.  Gearing ratios (e.ACCA F2 Management Accounting Chapter 5 Performance Measurement Mission Statement   It sets the broad purpose of the organization It is articulated in a mission statement. gross margin. debtor days and creditor days). which is an open-ended statement outlining the core values of the business.  Interest ratios (e. and describing the general way of doing business.g. current ratio and quick ratio).g. asset turnover.g.  Liquidity ratios (e. KEY KNOWLEDGE Financial Performance measures Included in financial performance measures is a range of ratios:  Efficiency ratios (e. Page | 35 .g. debt equity ratio). interest coverage).  Profitability ratios (e.

ACCA F2 Management Accounting Value for Money A useful way to judge performance in a not-for-profit organization is to apply the Value-forMoney method can be useful. It incorporates three elements. referred to as the 3 E’s:    Economy: Getting the best deal on inputs Efficiency: Converting inputs into the maximum number of outputs Effectiveness: Ensuring that organizational objectives are being met KEY KNOWLEDGE The scope of performance measurement Balanced scorecard The balance scorecard addresses a number of parameters (or “perspectives”) in monitoring business performance by asking the following questions:  Financial perspective: “To succeed financially how should we appear to our shareholders?” Customer perspective: “To achieve our vision how should we appear to our customers?” Internal business processes: “To satisfy our shareholders and customers what business processes must we excel at?” Learning and growth: “To achieve our vision how will we sustain our ability to change and improve?”    Page | 36 .

An Investment should be accepted if the RI is positive. The ROI measure is very similar to ROCE (return on capital employed) with the only exception being the use of profit in the formula: ROI = Net Profit Capital Employed ROI as defined above is commonly used for investment appraisal and for business sector (divisional) performance. If the corporate overall ROI target is 12%. Residual Income (RI) Convert results into monetary magnitudes: Residual Income Where Imputed interest = Capital Employed X Capital charge (or cost of capital) = Divisional EBIT (minus) Imputed interest A positive result adds profits to the division beyond the incremental capital cost. Page | 37 . especially if his bonus is based on ROI achieved. then the division head is missing a value-creating opportunity. EXAMPLE A division head with an actual ROI of 20% may be reluctant to accept a project offering a 15% ROI.ACCA F2 Management Accounting Return on Investment (ROI) at the Divisional Level Earnings can be measured at the divisional level in relation to the financial resources they use. whereas ROCE is common at the overall corporate level.

can relatemore easily to NFPIs (no. customer surveys that indicate a significant drop in customer loyalty. there is the risk of focusing only on improving financial results in the short-term while neglecting the long-term viability of the business. in other words. especially at the operational level.g. management can react more quickly to problems (e. length of time it takes to cook a cheeseburger). which can endanger the medium/long-term health of a business)   Page-38 . Companies increasingly resort to NFPIs since operational measures may provide a leading (or early) indicator of what becomes visible only later in the financial results.ACCA F2 Management Accounting Non-financial performance indicators NFPIs are important because:  They broaden management’s view of what needs to be mastered and measured in the organization. of tons of steel processed. Employees. if financial measures alone were used.

ACCA F2 Management Accounting END of the Notes .